EBIT-EPS (earnings before interest and taxes - earnings per share) calculations are important for all publicly traded companies. This analysis helps businesses decide on the best options to raise money. Companies usually have three choices: secure a loan (debt financing), issue preferred stock (with a stated interest rate) or issue common stock (with no payment obligations). The calculations for debt financing and the resulting EPS are relatively simple and straightforward.
Calculate EBIT-EPS for Debt Financing
Decide the amount of capital (money) needed by the company. All calculations are driven by the level of financing required. The available choices (debt, issue preferred stock or common stock) are affected by the amount of money required to meet company goals. Don't forecast too little money, as restructuring debt, particularly when requesting more funds, can be difficult, time consuming and often expensive.
Begin the calculations for debt financing with the EBIT, more commonly known as net operating income. This is the difference between a company's gross (total) operating income (sales) minus its operating expenses. Instead of an end point, EBIT is the starting point for debt financing calculations. EPS will be determined after the subsequent calculations.
Subtract the cost of the new debt for 1 year from the EBIT (either actual or projected). For example, the EBIT of the company was $60,000, the money needed is $100,000, and the interest rate is to be 5 percent. The cost of debt financing will be $5,000. Subtract the debt service (cost) from the EBIT to arrive at the EBT (earnings before taxes). In this case, the company has an EBT of $55,000.
Subtract projected taxes from the EBT. Assuming the company is liable for 25 percent tax contributions ($13,750), the EAT (earnings after taxes), which is also the true net income of the company, will be $41,250. Should tax rates change, use the projected new liability for this analysis.
Calculate the company's EPS. Because the company chose debt financing, no additional shares of common or preferred stock were issued and sold. In the example, assume there are 20,000 shares of stock outstanding. Divide the EAT ($41,250) by the outstanding shares (20,000) to learn that the EPS after this debt financing is $2.06 per share.
When unsure if debt financing is the best choice, project the EPS for the other options (issuing preferred or common stock) along with the cost of a new loan. If the debt financing comes with an adjustable interest rate, project potential increases in EPS calculations.
Carefully assess potential future EPS with debt financing, as net income may, or may not, remain at current levels. Don't accept an offer of debt financing until you are sure it is at or below market rates and terms.
- When unsure if debt financing is the best choice, project the EPS for the other options (issuing preferred or common stock) along with the cost of a new loan.
- If the debt financing comes with an adjustable interest rate, project potential increases in EPS calculations.
- Carefully assess potential future EPS with debt financing, as net income may, or may not, remain at current levels.
- Don't accept an offer of debt financing until you are sure it is at or below market rates and terms.